UK Election Eclipses Referendum Risk as Investors Hold EU Bets
With the UK general election less than a week away and no one any clearer about who is going to win, investors are refraining from bets on one of the biggest risks of its aftermath.
If the Conservatives are still in government after May 7, David Cameron has vowed to seek a better deal from the European Union and hold a referendum by the end of 2017 on whether Britain should leave after four decades of membership. Despite warnings from business leaders, analysts and politicians that the uncertainty could cost billions in lost investment and jobs, UK assets are displaying little concern.
“I don’t think the market is paying close enough attention to referendum risks should the Conservatives come to power,” said Phyllis Papadavid, a senior foreign-exchange strategist at BNP Paribas in London. “It’s a key risk we’ve been flagging. We’ve been recommending long positions on volatility.”
The pound had its best month against the dollar since September 2013 in April, while one-month implied volatility in sterling versus the dollar — a measure of expected price swings based on options prices — is at 11 percent, having retreated from 13.64 percent last month.
At the same time, 10-year government bond yields, at 1.83 percent, are only about 50 basis points off a record low.
“These days markets tend to talk about things but not price them because they realize a lot of the worst-case scenarios never materialize,” said Peter Dixon, an economist at Commerzbank in London. “A Conservative-led government could be positive for markets in the short term even though in the long run that may be a less positive outcome for markets. I don’t think it makes any sense to start pricing it on May 8 or whenever we finally know the composition of the government as there are so many unknowns.”
Britain sends almost half its exports of goods and services to the EU — 227 billion pounds ($349 billion) last year — and foreign companies operating in the UK gain tariff-free access to a market of 500 million people in 28 countries.
Former Labor Prime Minister Tony Blair entered the election fray last month with a warning that even the threat of quitting the EU would inflict “chaos” on the economy. British Chambers of Commerce Director General John Longworth says a referendum should take place soon to avoid uncertainty for business.
The arguments for staying in count for little among many Tories, who blame the EU for rising immigration, excessive regulation and undermining British sovereignty. Cameron offered the referendum in early 2013 to win back voters from the anti-EU UK Independence Party, and he’d almost certainly make the pledge a condition of any coalition agreement. Surveys of voters suggest a referendum could go either way.
So could the election next week, with polls continuing to suggest neither the Conservatives nor the Labor opposition will win enough parliamentary seats to govern without the support of smaller parties.
Labor leader Ed Miliband has made his refusal to hold a referendum his main pitch to business, which has criticized other Labor commitments such as raising taxes on big companies and the wealthy. When HSBC Holdings announced last week it was considering moving its headquarters out of the UK, Miliband said the decision underscored the folly of Cameron’s pledge.
While HSBC said regulations introduced since the financial crisis were the main motivation for the review, Chairman Douglas Flint warned that the importance of EU markets to British trade makes it riskier for the UK to leave the bloc than try to overhaul it.
Moody’s Investors Service said last month that while uncertainty over the election outcome isn’t affecting Britain’s credit profile, an increased likelihood of leaving the EU “could result in negative rating pressures over the medium term.”
Until the shape of the next government is known, investors remain sanguine.
“Even if you try to analyze the implications it is really hard to figure out what they would be,” said Anke Richter, senior credit analyst at Conning Asset Management in London. “There are a lot of moving parts.”
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